Money Runs

Abstract

We develop a model in which, as in practice, bank debt is both a financial security used to raise funds and a kind of money used to facilitate trade. This dual role of bank debt provides a new rationale for why banks do what they do. In the model, banks endogenously perform the essential functions of real-world banks: they transform liquidity, transform maturity, pool assets, and have dispersed depositors. Moreover, they make their debt redeemable on demand. Thus, they are endogenously fragile. We show novel effects of narrow banking, suspension of convertibility, and some other policies.

Compressing Over-the-Counter Markets

“…These results are analogous to the adverse effect of partial netting in central clearing shown by Amini et al (2016). In general, Donaldson and Piacentino (2018) show that maintaining offsetting claims may be rational for banks because of the capacity to dilute transfers. However, the authors show that, when internalised, these individual benefits can generate high levels of interconnectedness which ultimately make the system more fragile in the event of a liquidity crisis.…”

“…At the intensive margin, counterparties may be selective in the trades they disclose to their service provider as compression implies possible shifting of trading relationships. Further, hedging strategies associated with specific positions may also prevent some forms of netting to be accepted by individual participants (Donaldson and Piacentino, 2018).…”

Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking

“…On one equilibrium path, users never withdraw en masse and continuously trade tokens at the dynamic price Pt. The other equilibrium paths feature runs (related to the dynamics in Donaldson and Piacentino (2020)). In the no-run equilibrium our analysis carries through as long as there exists a liquidation lower bound on Ct. 33 Routledge and Zetlin-Jones ( 2021) study the speculative attacks on under-collateralized stablecoins that are akin to those on currencies (Morris and Shin, 1998;Goldstein, Ozdenoren, and Yuan, 2011).…”

Going-Concern Debt of Financial Intermediaries

“…A prominent strand of research since Diamond and Dybvig (1983) studies liquidity pro-vision through financial intermediaries' deposit liabilities (Gorton and Pennacchi, 1990;Kashyap, Rajan, and Stein, 2002;Hanson, Shleifer, Stein, and Vishny, 2015;Donaldson and Piacentino, 2020;Ma, Xiao, and Zeng, 2020). Following the 2008 financial crisis, a number of papers examine the asset-based debt of financial intermediaries, such as repos and asset-backed commercial papers (Gorton and Metrick, 2012;Krishnamurthy, Nagel, and Orlov, 2014).…”